Stites on Estateshttps://www.stitesonestates.com
Perspectives on estate, trust & tax planning for private clients and family businessMon, 16 Jul 2018 23:31:54 +0000en-UShourly1https://wordpress.org/?v=4.9.7What to Do with an Estate with Foreign Assets (Even that “Little” Bank Account in Europe)http://feeds.lexblog.com/~r/StitesOnEstates/~3/8yjnkfiGpjU/
https://www.stitesonestates.com/2016/03/what-to-do-with-an-estate-with-foreign-assets-even-that-little-bank-account-in-europe/#respondMon, 14 Mar 2016 21:28:26 +0000http://www.stitesonestates.com/?p=3361Continue Reading]]>This article regards estates of decedents who owned foreign assets and the tax and reporting requirements. Many people are quite shocked to learn about the reporting requirements for foreign bank accounts, in particular. After all, tax is typically being paid in the foreign jurisdiction, or perhaps the foreign bank accounts generate little to no income that is taxable anyway. There are, however, two categories to be concerned with, first, of course is taxation. Second is reporting in and of itself. How does this all relate to estates? Well, if the estate has foreign assets and the proper reports are not made, then the personal representative of the estate could be liable.

One of the main reporting obligations is actually not an IRS form at all, it’s a treasury department Form FinCen 114, commonly called an FBAR (Foreign Bank Account Report). It’s part of the financial crime enforcement network, and if the foreign bank accounts in the aggregate exceed $10,000 at any point during the year (even very briefly) then this report must be electronically filed. The penalties for failure to file can be quite draconian, including willful penalties of 50% or more of what is not reported. Again, note that this filing has nothing to do with the amount of tax owed, if any. If a person has signature authority of foreign financial accounts then there can also be a reporting requirement, even if there is no financial interest in the account. As such, one should be careful about the accounts that a person has signature authority over. Similarly, one should be careful about having a power of attorney over one’s parents who have a foreign account, as there could be a reporting requirement.

As for tax reporting, several years ago an act of Congress commonly called FATCA added Form 8938, Statement of Specified Foreign Financial Assets. It is very important that this form is filed, since the statute of limitations never runs if it is not – meaning that there could be a potential tax problem forever. The IRS recently released regulations requiring this form to be filed by certain domestic entities as well.

Foreign mutual funds held in an estate of a United States citizen or resident are particularly problematic. A United States citizen or resident should never own foreign mutual funds due to the extensive reporting under Form 8621, PFIC shareholder filings and the often very unfavorable tax treatment and the difficulties in obtaining information from often very reluctant foreign financial institutions (FATCA and PFICs are two of the main reasons it’s often hard for United States citizens and residents to open accounts overseas). Although there may be some elections available to alleviate some of the tax burden, foreign financial companies often refuse to supply the needed information.

Of course, some will wonder how the IRS would ever know about these accounts. Well, FATCA requires foreign financial institutions to identify and report US holders of non-US financial accounts. The US already has agreements with most countries for this reporting.

The major forms to be concerned with are set forth in the list below. This is not an exhaustive list and not every form is needed in every circumstance. The form number is listed with its title in parenthesis:

FinCen 114 (Foreign Bank Account Report),

Form 926 (Transfers to Foreign Corporations),

Form 1042 (Payments to Foreign Taxpayers),

Form 3520, 3520A (Foreign Trusts),

Form 5471 (US Owned Foreign Companies),

Form 5472 (Foreign Owned US Companies),

Form 8233 (Independent Personal Services by Nonresident),

Form 8621 (Passive Foreign Investment Corporations),

Form 8833 (Treaty Based Disclosure Form),

Form 8840 (Closer Connections Form),

Form 8858 (Foreign Disregarded Entities),

Form 8865 (Foreign Partnerships),

Form 8938 (Specified Foreign Financial Assets),

Form W-8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding).

Now, back to the subject of personal representative liability. Pursuant to Title 31 U.S.C.§3713(b) any personal representative who pays “any part of a debt of the . . . estate before paying a claim of the Government is liable to the extent of the payment for unpaid claims of the Government.” Therefore, the personal representative may be liable for taxes, interest and penalties if the distribution leaves the estate unable to pay the government and the personal representative had notice of the government’s claim. In terms of notice “the executor must have knowledge of the debt owed by the estate to the United States or notice of facts that would lead a reasonably prudent person to inquire as to the existence of the debt owed before making the challenged distribution or payment.” United States v. Coppola, 85 F.3d 1015, 1020 (2d Cir.1996). Therefore, there is a duty of inquiry regarding the existence of these obligations, and as such important that the proper reporting is done and taxes paid.

The good news, however, is that much of the reporting, aside from the PFIC reporting of course, is actually not very difficult. Moreover, there are generally tax credits that can be used due to foreign tax paid, meaning that the US tax liability is often quite small. If there are past years that have not been reported, the government currently offers several different programs to settle the tax and reporting obligations for reduced penalties (provided that a person comes forward prior to receiving IRS notice). Considering the severity of the penalties, proper reporting is obviously very advisable.

]]>https://www.stitesonestates.com/2016/03/what-to-do-with-an-estate-with-foreign-assets-even-that-little-bank-account-in-europe/feed/0https://www.stitesonestates.com/2016/03/what-to-do-with-an-estate-with-foreign-assets-even-that-little-bank-account-in-europe/Estate Planning With Partnerships: Important New Considerationshttp://feeds.lexblog.com/~r/StitesOnEstates/~3/mO-p5ZMYowE/
https://www.stitesonestates.com/2016/02/estate-planning-with-partnerships-important-new-considerations/#respondTue, 16 Feb 2016 00:33:24 +0000http://www.stitesonestates.com/?p=3358Continue Reading]]>Two recent acts of Congress (including the rather interestingly named Protection of Americans from Tax Hikes Act) created new audit rules for partnerships. Normally one would not think that a change to “audit rules” would impact estate planning. However, many estates have LLCs taxed as partnerships, or even limited partnerships or limited liability partnerships, which are used as family limited partnerships in order to obtain valuation discounts through lack of control and lack of marketability (provided that all of the proper procedures and documentation is followed). Moreover, many estates have revocable trusts that own limited liability companies, which is a common way to avoid the often lengthy process of probate for business assets. Again, these techniques are quite common.

So what are the new audit rules, and how do they impact estate planning? Briefly, starting in 2018 the new audit rules allow for a partnership level determination of deficiencies if the partnership is audited as the default regime. The problem with this determination is that if there are different partners currently than the year under audit, then the current partners could end up being liable for the past deficiency. There also can be issues with allocation, since the IRS won’t undo erroneous allocation and will simply assess the net increase against the partnership. Another problem is that this deficiency will be assessed at the highest tax rates. The tax matters partner is no longer, and instead there is a partnership representative who does not even need to be a partner. It will be important to select a partnership representative since the IRS gets to choose the representative if one is not selected. Due to the possible negative consequences of the new laws, many partnerships will want to opt out (which will keep determinations at the partner level). The issue is whether trustees that own partnership interests on behalf of trusts will be able to opt out.

The new audit rules allow opting out if there are less than 100 K-1s, and the “each of the partners of such partnership is an individual, a C corporation, any foreign entity that would be treated as a C corporation were it domestic, an S corporation[note that there are some additional rules for S Corps], or an estate of a deceased partner.” Unfortunately the new code section does not mention trusts or trustees at all, so it is currently unclear as to whether partnership that have trusts as owners will be able to opt out. I recently attended a tax conference, and the IRS representative on a panel there informally stated that there would likely be regulations regarding grantor trusts and the ability to opt out (the new audit rules do allow the IRS to prescribe similar rules for other partners not listed in the new code section).

What to do now? For partnerships, family limited partnerships, limited partnerships, limited liability partnerships (and limited liability limited partnerships), as well as LLCs taxed as partnerships, that are currently being formed, it would be prudent to include some of the language from the new code in partnership and operating agreements in order to insure later that the entity is in compliance, in case the partners do not return to amend the agreements. For existing partnerships, it makes more sense to wait to amend as more regulations are promulgated by the IRS. Extra caution should be taken regarding trusts (particularly non-grantor trusts) as owners, since it is unclear how or if partnerships with trustee owners will be able to opt out.

]]>https://www.stitesonestates.com/2016/02/estate-planning-with-partnerships-important-new-considerations/feed/0https://www.stitesonestates.com/2016/02/estate-planning-with-partnerships-important-new-considerations/Designing Trusts for a Surviving Spouse’s Remarriagehttp://feeds.lexblog.com/~r/StitesOnEstates/~3/jw5d9seODHQ/
https://www.stitesonestates.com/2015/08/designing-trusts-for-a-surviving-spouses-remarriage/#respondSun, 23 Aug 2015 01:15:52 +0000http://www.stitesonestates.com/?p=3357Continue Reading]]>In the 90s, when the Internet was new and Bill Clinton still had more tomorrows than yesterdays, the estate tax exemption was $600,000, an amount even Thomas Piketty might think was rather low.

In that sort of environment, credit shelter trust planning for married couples felt almost mandatory.

We live in a very different world today. The Internet, no longer new, has gone social and mobile. A Clinton third term may occur.

One of the most significant non-tax reasons to use a trust is planning for a surviving spouse’s remarriage.

What are the risks to family wealth when a surviving spouse remarries, and how can using a trust (and designing that trust thoughtfully) reduce them?

Asset Leakage to a New Spouse. We’ve covered these risksindepth. Simply put, Kentucky’s elective share statute allows a surviving spouse to elect against their deceased spouse’s will, and instead receive one-half of their deceased spouse’s probate estate (except real estate, in which a surviving spouse has only a one-third elective share).

If your spouse has inherited outright from you, and doesn’t get a prenuptial agreement before remarrying, and their second spouse survives, the second spouse has strong economic incentives and the legal right to divert half of the inheritance your spouse received from you away from your descendants.

Does that sound like a good outcome to you? (I’d expect it doesn’t.)

Placing a spouse’s inheritance into trust solves the elective share problem, because assets remaining in the trust at your spouse’s death won’t be included in your remarried spouse’s probate estate – the asset “bucket” that’s vulnerable to the elective share statutes.

A Surviving Spouse as Gold-Digger’s Target. You don’t have to follow the media in any particular depth to see numerous examples of wealthy widow(er)s finding themselves remarried under circumstances that may not relate entirely (or at all) to true love.

When a substantial inheritance is held in trust, it’s much easier for a surviving spouse to be more confident that a suitor is interested in him or her, and not their wealth.

It also makes it much more likely that relationships among a surviving spouse, his or her children, and their new stepparent won’t be strained by fear of disinheritance.

New Half-Siblings. If a surviving spouse has or adopts additional children, the new spouse is likely to seek ways to increase inheritance for those children at the expense of their child’s half-siblings.

Bluntly: if a surviving spouse’s inheritance isn’t held in trust, and the spouse has additional children, the deceased spouse’s children are likely to eventually inherit less.

Using a trust is a first step to protect the long-term flow of wealth to descendants even if a spouse remarries, but it shouldn’t be the last.

How the trust is designed can be just as (or even more) important. Trust design issues to consider carefully include:

Who Should Control the Funds? If your surviving spouse is trustee of the trust when he or she is remarried, practical risks present themselves. Will the new spouse encourage your surviving spouse to be (overly) generous in distributions? It’s not unlikely.

A simple solution to this potential problem is to provide that a surviving spouse may serve as trustee of the trust for his or her benefit only when not remarried.

Should a Spouse’s Inheritance Provide “First” or “Last” Dollar Spending?

Most married couples I represent want a surviving spouse to be provided for as generously as possible, and of course this instinct makes sense.

But if a spouse remarries a wealthy person (or a person who likes the finer things in life), should generous distribution standards in a trust directly or indirectly subsidize an enhanced lifestyle for the new spouse?

Will generous distribution standards allow rapid depletion of the trust, and accumulation of wealth outside the trust – wealth which might pass to the new spouse, or to new children?

To reduce these risks, a trust could provide that at any time a surviving spouse is remarried, the spouse himself or herself couldn’t be trustee, and that the successor trustee should consider the availability of other assets and income available to support the spouse when making distribution decisions.

What Control Should a Spouse Have Over Ultimate Flow of Trust Assets?

Trusts often include powers of appointment allowing a beneficiary to direct the distribution of remaining trust assets when the beneficiary is no longer living.

When narrowly drafted, powers of appointment often limit the “permissible class” of appointees to the descendants of the person whose wealth funded the trust.

When drafted more broadly, powers of appointment may permit assets to be appointed not only among descendants, but to any person or entity.

(Sometimes the person holding the power is allowed to appoint to themselves, their estate, their creditors, or the creditors of their estate – a general power of appointment. Other times these potential appointees are excluded – a limited power of appointment.)

Whether general or limited, broadly written powers of appointment provide valuable flexibility – as, for instance, when a surviving spouse might choose to appoint assets to support worthwhile philanthropic objectives, without unreasonably depleting descendants’ inheritance.

When a surviving spouse remarries, broadly written powers of appointment can lead to unintended consequences and discord.

A surviving spouse allowed to appoint trust assets to any person or entity certainly might direct them away from descendants in favor of a new spouse, or to additional children, or to a new spouse’s children.

Although imperfect, potential ways to reduce risks relating to powers of appointment held by a spouse include limiting permissible appointees to descendants and/or charities, and providing that at any time after a spouse has remarried, the spouse may only appoint to descendants, rather than to any person or entity.

Remarriage of a surviving spouse may not be a topic spouses want to discuss in depth, but at the very least, it’s one their advisors should keep in mind, and seek opportunities to plan for thoughtfully.

]]>https://www.stitesonestates.com/2015/08/designing-trusts-for-a-surviving-spouses-remarriage/feed/0https://www.stitesonestates.com/2015/08/designing-trusts-for-a-surviving-spouses-remarriage/Designing Incentive Trusts: Adam Smith and The Wealth of Beneficiarieshttp://feeds.lexblog.com/~r/StitesOnEstates/~3/gWWEUDFrdVI/
https://www.stitesonestates.com/2015/08/designing-incentive-trusts-adam-smith-and-the-wealth-of-beneficiaries/#respondSat, 15 Aug 2015 20:14:15 +0000http://www.stitesonestates.com/?p=3354Continue Reading]]>Certainly one of Adam Smith’s core insights in The Wealth of Nations was that incentives matter.

Once a family develops clarity on the key questions above, they and their advisors can consider a wide range of incentive trust design options, including:

Delay distributions until certain age(s).

Reducing distributions (or delaying them entirely) until a beneficiary reaches a particular age (for instance, 30, 35, or 40) will have incentive effects on career choice, attention to studies, and workforce effort when a beneficiary is young.

It’s easy for young adults to overestimate the long-term financial security provided by a particular amount of assets.

Remember when you were in college – didn’t $100,000 seem like an almost “infinite” amount of money? Now, at mid-career or nearing retirement, perspective changes, doesn’t it?

Because careers last so long, and the compounding effects of income differences can grow so large, avoiding distortions in beneficiary career choice because they (incorrectly) feel they “don’t need to earn very much” can be a very positive outcome of delaying distributions until somewhat older ages.

Delay distributions until certain accomplishment(s).

A family might want to use the “carrot” of future trust distributions to encourage a beneficiary to complete college and/or graduate school in a timely manner – avoiding the “perpetual student” problem.

Alternatively, a very wealthy family with beneficiaries who will not need to work for economic reasons might, nonetheless, want beneficiaries to gain experience and perspective from paid employment for while, before receiving a large inheritance.

A family with a closely held business which they hope descendants will enter might require the child to work in the business (or, more commonly, gain experience working outside the business) before receiving distributions.

Allow a beneficiary to be his or her own trustee on certain conditions.

Trusts can provide asset protection from creditors and divorce that can be difficult for even the most responsible and competent beneficiary to replicate on his or her own.

Even so, trusts are also commonly used to protect assets from being depleted by bad beneficiary decisions.

With these issues in mind, a trust could be designed to initially use a third-party or corporate trustee, but permit a beneficiary showing maturity and stability to be his or her own trustee.

Although there’s no airtight way to measure maturity and stability, one can try.

For instance, a person who has stayed out of jail, avoided bankruptcy, completed college and/or graduate school, and gotten and stayed married to the same person for a long period is more likely to be stable than a person who has done none or few of those same things.

Once a family settles on attributes of maturity and stability that fit its goals and values, the qualifications for a beneficiary to be his or her own trustee can be written into the trust agreement accordingly.

Only permit distributions for certain purpose(s).

If a family wants to dilute the effects money will have on their beneficiaries, they could limit distributions to particular purposes – for instance, funding educational expenses, or paying for unusually large health care bills.

Because other purposes (such as vacations, or buying a larger house, or retiring early) wouldn’t be permitted purposes for distributions, beneficiaries might be less likely to make career choices or design lifestyles that families believe aren’t desirable.

Reduce distributions when a beneficiary is not working.

Wealthy clients often want to make sure that beneficiaries live in safe circumstances with a certain dignity (a “minimum lifestyle”) even if they turn out to be very low functioning (for instance, due to mental illness, substance abuse, or perhaps just outright laziness).

On the other hand, they usually don’t want a beneficiary’s incentives to work productively to be reduced or removed because of trust distributions.

One way to balance these concerns is to provide for a trust to make an inflation-adjusted minimum distribution (for instance, $50,000) at any time a beneficiary is working age and not disabled or providing full-time care to minor children, but make the trust’s distribution standards much more generous if a beneficiary is working, past ordinary retirement age, disabled, or providing full-time care to minor children.

Use distributions to “match” income from a job or a business.

It’s a very values-driven decision whether a wealthy family prioritizes descendants being economically successful (e.g., investment banker) or instead perhaps just being productive and happy (e.g., boarding school teacher).

If a family does want to transfer wealth to descendants, but still provide ordinary (or even enhanced) incentives for wealth creation by beneficiaries, a trust can certainly be designed to do that.

For instance, a trust could distribute a fraction (or a multiple) of a beneficiary’s documented W-2 income, or distributions received from a closely held business. If a family was ambitious, and tolerant of complexity, the extent of matching could be varied at different levels of income.

Obviously, trust design could differ substantially, depending whether a family’s goal was for children to amass as much wealth as possible, or instead for children to achieve a certain level of income, and then focus on other priorities (such as health, creative pursuits, or relationships with friends and family).

Reduce or stop distributions when a beneficiary isn’t substance-free.

It’s not too difficult to design a trust that provides substantial financial incentives for sustained recovery from substance abuse problems. Testing for substance use (paid for by trust assets) and negative test results could be a condition to receive distributions.

In addition, the trustee could be expressly indemnified from trust assets against all costs (including legal fees) relating to any effort by a beneficiary to challenge the trustee’s distribution decisions.

The result would be that a disgruntled (and, possibly, addicted) beneficiary would be depleting his or her own eventual inheritance if the beneficiary sued the trustee.

Based on what a family believes is best for each beneficiary, the incentive trust design options outlined above (along with others) can be combined in a myriad of ways to customize incentive trusts with a personalized, individualized approach.

And that raises a larger question: are incentive trusts a good idea?

I believe that’s a decision for each family to make – and not one for a trust and estates attorney to impose.

I’ve seen many situations where incentive trusts weren’t used, but very difficult and unpleasant outcomes could have been avoided if they had been.

I’ve seen other situations where incentive trusts were poorly aligned with a beneficiary’s actual circumstances, and beneficiaries were very resentful.

At a minimum, families considering whether an incentive trust might fit their circumstances should know their wide array of options, consider them carefully, and apply them thoughtfully.

As a high estate tax exemption has reduced the tax-driven imperatives for using trusts to hold inheritances, non-tax applications of trusts come to the fore.

As non-tax issues in trust design assume greater relative importance, what factors should a family consider when deciding whether to use a trust?

If they will use a trust, how should that trust be designed?

To answer these questions, a family should do the best it can to look ahead to its future, and make reasonable (but unavoidably imperfect) estimates of what its future might look like.

That takes us back to the Quadrant at the heart of a Life Cycle approach to estate and financial planning, with its four domains of Facts, Forecasts, Life Stages, and Unexpected Events.

The decision whether or not to use a trust to hold an inheritance begins with a family’s Facts.

Who would be receiving the wealth?

The array of options includes the obvious, but thinking about the beneficiaries is the right place to start.

Common potential inheritors include a widow(er), a surviving spouse and children, adult children, nieces or nephews, parents, siblings, and/or charities.

What will the trust’s funding level be?

Funding is a tremendously important Fact underlying good trust design.

Funding often occurs during estate administration, when probate and non-probate assets (such as retirement accounts and life insurance proceeds) are gathered, and transferred to the trust.

A quick review of a family’s balance sheet will suggest the anticipated potential funding level for a trust.

Funding is only the first stage of a trust’s life cycle; the stage that follows is administration – investing the trust’s assets and making distributions to its beneficiaries.

Designing a trust well requires taking into account the Life Stages of the beneficiaries during the trust’s term.

For instance, if clients are a married couple with young children, the trust might need to “financially parent” the children through primary and secondary school, and then possibly college and graduate school.

In contrast, if a married couple had adult children, the trust might be protecting assets for those adult children to help boost the children’s retirement savings.

It might also be protecting against claims of a child’s creditors, or against loss of assets to divorce by preventing commingling a child’s inheritance with marital property.

The Life Stages of a trust’s beneficiaries will suggest how long the trust should last, as well as the “exit strategy” for trust assets – the distribution stage of the trust’s life cycle.

Examples of distribution options for trust assets include:

All at once. The trust might distribute its remaining assets among beneficiaries when its youngest beneficiary attained a specific age.

Stages – at times. The trust might make partial distributions at particular times (such as 5, 10, and 15 years after funding). This approach fits when clients think good financial decisions come with opportunities to learn through experience, or even by making poor choices about the use of early distributions.

Another key variable in deciding on the best distribution design for a trust requires a Forecast of the remaining value of assets in the trust at the time of distribution, the number of beneficiaries at the time of distribution, and – by extension – the likely amount of distributions to each beneficiary.

Like any Forecast, uncertainty can’t be avoided, but reasonable forecasts aren’t impossible.

It’s important to align Forecasts of a trust’s remaining assets with its distribution design.

If a trust would be funded with $5 million and its pricipal purpose would be to pay for college and graduate school for a couple’s sole child, an outright distribution of remaining trust assets when the child attains age 25 may not be wise.

Similarly, if a family has four children, none over age 10, and the trust would be funded with $1.5 million, keeping remaining assets (after all the children are raised and educated) in separate lifetime trusts for each child may be more complicated than necessary.

Trust design should also incorporate Unexpected Events – occurrences that aren’t uncommon in the overall population, but tend to take any individual or family by surprise (such as divorce, an illness, the birth of a special needs child, or a spouse living much less than their life expectancy).

Simply put, the more Life Stages a trust’s administration will cover, and the more assets it will hold, the more closely clients should consider ways to make the trust adaptable to Unexpected Events.

Examples of planning for flexibility in the face of Unexpected Events include decanting, powers of appointment, and defining precisely who may be a qualified trustee in various circumstances.

With these variables in mind, it’s possible to evaluate on an individualized, case-by-case basis whether and how a trust might be helpful – even in situtations not dominated by estate tax issues.

Future posts will explore some of these situations, which include:

Anticipating a spouse’s remarriage

Planning to conserve family assets when a surviving spouse is very elderly

Protecting family assets against a child’s divorce

Using a trust as a substitute for a prenuptial agreement

Defending against sons- or daughters-in-law who make unwise business or spending decisions

An “asset protection wrapper” for a child’s inheritance

Protecting a family’s core capital for grandchildren, when children seem unlikely to make good financial decisions

Incentive trusts to encourage particular behaviors and choices by descendants

For each of these situations, when clients and their advisors thoughtfully consider Facts, Forecasts, Life Stages, and Unexpected Events, they’ll likely reach better estate and financial planning outcomes.

]]>https://www.stitesonestates.com/2015/08/design-factors-for-your-familys-trust/feed/0https://www.stitesonestates.com/2015/08/design-factors-for-your-familys-trust/Minor Children and IRA/401Ks Beneficiary Designations: Dangers and Concernshttp://feeds.lexblog.com/~r/StitesOnEstates/~3/2otGN_FSaDg/
https://www.stitesonestates.com/2015/07/minor-children-and-ira401ks-beneficiary-designations-dangers-and-concerns/#respondMon, 20 Jul 2015 16:20:46 +0000http://www.stitesonestates.com/?p=3338Continue Reading]]>As a parent, one of the most difficult issues that I have had to deal with is what would happen to our young child should anything happen to my wife and I. No one likes to contemplate their own mortality or the idea of not being there to watch their children grow up. Unfortunately, mortality is inescapable, and proper planning is essential. Often people believe that once they have their Will drafted everything will be settled. This is rarely the case.

The first concept to understand is probate versus non probate in terms of assets. Assets owned directly by you, and that do not have a beneficiary designation (or survivorship/tenants in the entirety, etc.), will generally be a part of your probate estate. This means your Will would be able to direct where these assets go. For accounts with beneficiary designations, such as IRAs, 401Ks, life insurance, certain bank accounts (as well as joint with survivorship or pay on death or transfer on death designations), certain financial accounts (with named beneficiaries), and even some real property (joint with survivorship, tenants in the entirety, etc.) might all pass outside of probate. Your Will would have no effect whatsoever on how these non-probate items are distributed. Instead, those non-probate items would be distributed in accordance with the various beneficiary designations (or through survivorship or tenants in the entirety, etc.), regardless of what is written in your Will. Since these items could make up the majority of your estate, it is important to plan properly.

One idea that many people have is to simply name their estate as the beneficiary and therefore have those assets come under control of the Will. However, naming the estate as the beneficiary can be disastrous for qualified plans (IRAs, 401Ks, etc.), as such designations generally have adverse tax consequences and may have adverse asset protection consequences.

What happens if assets go directly to a minor child? Generally, if it is more than a certain amount (as determined by the states, usually about $15,000-$20,000), the parent/guardian would not be able to simply hold the child’s assets, and a conservatorship would have to be obtained. Until the child reaches age 18, the conservator would have to be bonded (which can be expensive), and the court would be involved in determining how the money is spent. Upon reaching age 18, the child would get the full value of the assets. For most families conservatorships should be avoided through proper planning.

One solution is to have the minor named as beneficiary pursuant to one of the uniform transfers to minor’s acts of the various states. The downside to this designation is that not all qualified plans allow for this designation, and there is little flexibility, as the child will get everything remaining at age 21, which may not be what is desired.

Another solution is to create a trust, and have the trust be the beneficiary of the funds. The trust can be created either as a stand-alone document, or created via the Will as a testamentary trust. Great care should be taken in the creation of this trust.

If the deceased dies after their Required Beginning Date for Minimum Required Distributions (April 1 of the year following the year in which the deceased turned 70 ½) than any Required Minimum Distributions from the qualified plans (IRAs, 401Ks, etc.) would be based upon that decedent’s life expectancy, unless the trust properly sets forth a Designated Beneficiary or Beneficiaries (which would generally be your children). If a proper Designated Beneficiary is set up, then the distributions would be based on the longer of the oldest beneficiary’s life expectancy or the deceased’s life expectancy. It may be beneficial, especially if there is a lot of difference in age between the children, to set up multiple trusts each with a different Designated Beneficiary (i.e. child) so that the stretch-out of the payments isn’t limited to the lifespan of the oldest child. If the deceased dies before their Required Beginning Date and there is no Designated Beneficiary, then the entire balance of the account must be distributed within five years of the date of the deceased’s death, which is a terrible result. The longer the distributions can be stretched out the longer the tax is deferred (and perhaps at a lower rate as well since income taxes are on a graduated scale) and the longer tax free growth is allowed for the funds remaining in the qualified plan.

You would generally have your spouse named as primary beneficiary, and then the trust (or trusts) as contingent beneficiaries. The spouse would have the option of rolling over his or her inherited IRA into their own IRA (which would then provide asset protection once it is rolled over), and the properly drafted trust (which follows all of the rules regarding designating a beneficiary) would provide asset protection to the non-spousal beneficiaries. A recent Supreme Court case stated that inherited IRAs are not asset protected since they are not retirement accounts, and that is why the spousal rollover, and the trust for the contingent beneficiaries, is important from an asset protection standpoint (unless your state already protects inherited IRAs anyway).

The final issue to be careful of in regard to trusts for qualified plans regards accumulation of income. It may be desirable from an asset protection standpoint to accumulate the distributions in the trust. The downside to having distributions accumulate in a trust (rather than distributing annually) is that trusts are taxed at disfavorable rates. Trusts reach their maximum tax bracket at only $12,150 of income. Therefore, how and when to distribute the distributions coming into the trust from the qualified plan must be carefully considered.

As for other assets (other than from qualified plans), generally the trust can either own the asset directly or the trust can be a beneficiary. Depending upon the tax, estate planning, and asset protection objectives, these trusts can be set up in a variety of ways, and as such a qualified attorney should be consulted as to the appropriate structure depending upon the particular facts of the situation.

Hopefully this article provides a good, brief overview of an often overlooked part of estate planning, e.g. the importance of checking all of one’s beneficiary designations and checking all of one’s deeds, account titles, etc. Do not simply assume that the Will can take care of everything, because often a Will might have no effect whatsoever of a great deal of a person’s property.

]]>https://www.stitesonestates.com/2015/07/minor-children-and-ira401ks-beneficiary-designations-dangers-and-concerns/feed/0https://www.stitesonestates.com/2015/07/minor-children-and-ira401ks-beneficiary-designations-dangers-and-concerns/Design Options for Education Trustshttp://feeds.lexblog.com/~r/StitesOnEstates/~3/M_QVpJIS3R8/
https://www.stitesonestates.com/2015/07/design-options-for-education-trusts/#respondSat, 18 Jul 2015 22:06:57 +0000http://www.stitesonestates.com/?p=3335Continue Reading]]>I often work with “Wealth Creators” who have built substantial wealth themselves, most notably as founders of companies or early-stage employees at startups.

I also work with “Inheritors” managing wealth built in prior generations for the benefit of descendants.

Although every instance has unique aspects, in general, I find that Wealth Creators have conflicted feelings about what being Inheritors will mean for their descendants.

They often tell me they don’t want their children to have “too much” wealth.

Obviously, this presents a difficult question: how much wealth is too much? Answers to that question vary.

Amidst that variance, a very common instinct is that even if they aren’t confident about whether their children (or, instead, charity) should receive the bulk of their wealth, they do want to leave assets in trust to pay for their descendants’ education.

This instinct makes a tremendous amount of sense, and I never discourage it.

Education is a critical component of human capital formation, and human capital has often been the unique element in why any particular Wealth Creator built such success.

If funds are going to be left in trust for descendants’ education, what should the key provisions of those trusts be?

If a family doesn’t have detailed preferences, an education trust will probably be written to provide for the “education” of descendants.

A more specific trust might expressly include independent primary and secondary schooling, along with undergraduate and postgraduate education.

This is all well and good but (for Wealth Creators especially) it sometimes raises concerns about descendants becoming “professional students.”

No one wants to be anti-intellectual, but it is often true that certain programs of study feature a higher return on investment than others, and that the costs of various programs (even those in the same field) vary dramatically.

In the last several years, I’ve seen Wealth Creator clients take two particularly thoughtful approaches to reducing risks posed by the “Professional Student Problem.”

You could describe the first approach as the “State University Funding Cap.”

A client taking this approach might limit annual trust distributions for education to the then-current combined tuition, room, and board charged by the in-state public flagship university where the beneficiary is then living. (For reference, that amount is $26,700 at the University of Kentucky this year.)

The trust might also provide that such distributions would be made for only four years (for undergraduate work), or for the standard length of the graduate program that was being funded.

A second approach is “Loan Payoff Upon Completion.”

With this approach, a beneficiary might assume student loans, but if a program was completed on time (and perhaps with a minimum GPA), then the trust could make distributions to pay off the loans.

I think trusts written for this purpose are best designed when they anticpate the following trust administration issues:

If a trust is only intended to fund beneficiaries’ education, then there may be years (or periods of many years) when no descendants require any distributions for education, and it might make sense for the trust to acknowledge this.

It’s very likely that certain branches of a family will have more descendants than other branches. Settlors should consider actual (or perceived) fairness issues that may arise as time passes, and a family tree changes.

In most situations, the eventual expansion of a pool of descendants and trends in education cost inflation will likely leave the trust substantially depeleted. An inflation-adjusted minimum floor (for instance, $250,000 or $500,000) below which the trust will be distributed outright to family or charitable remainder beneficiaries may make very good sense.

These “family educational endowment” trusts tend to last a long time. For that reason, using a corporate trustee may make more sense than using an individual trustee. If the trust is intended to fund education costs of more than one branch of a family, any particular family trustee might be biased, and using a corporate trustee can increase actual (and perceived) fairness in trust administration.

It’s been interesting working with both Wealth Creator and Inheritor clients to help them create education trusts.

You won’t often meet a client with strong opinions about allocations between principal and income, or about estate tax apportionment.

In contrast, almost everyone tends to have strong opinions about what they want for education trusts.

It’s natural that these opinions would reflect their own experiences and values. I think that’s appropriate.

After all, isn’t education all about one generation passing to the next not only knowledge, but also experiences and values?

The takeaway for clients and their advisors is that personalized design of education trusts so that they fit a particular family’s needs and situation is possible – and it may be one of the most important “non-tax” estate planning issues.

The simplest approach (but in my experience, one that is not that common) may be to sell all of the property and divide the proceeds as directed in the estate plan.

Positives of this approach include transparency and fairness, because sale proceeds can be accounted for, and money can be divided easily.

Negatives include the typically low sale value of the property, and a lost opportunity to preserve its sentimental value within the family.

A far more common approach is to “work it out” among the family.

The executor or trustee might ask beneficiaries which items they want and see if a consensus appears. If a particular item is a focus for more than one family member, a bit of trading might occur, or (in extreme cases) those items might be sold.

This approach often sorts itself out with surprising speed and not that much fuss.

Its advantages include keeping items in the family that family members want.

Disadvantages may arise if one beneficiary is particularly pushy, and another is conflict-avoidant. In these instances, items may be distributed, but bad feelings among beneficiaries may simmer afterwards.

Families use a “draft pick” approach less frequently, but this offers the opportunity for increased fairness, and a structure that may reduce conflict.

In a “draft pick” approach, beneficiaries might draw straws to determine the order in which they will select items, and then continue “rounds” of selection until no beneficiary wants any item that hasn’t yet been selected (these remaining items would probably be sold).

The positives of the “draft pick” approach include how easy it is for beneficiaries to understand, and how easy it is for executors and trustees to implement.

A potential negative is that (just like a sports draft), if there are a very few items that are much more desirable than the others, the draft results can be very lopsided – and this might leave beneficiaries grouchy.

An approach that is rather complicated (but may also be the most fair) is what I describe as Appraisal-Selection-Auction.

It works like this:

The household items are appraised (this is usually an estate administration procedural requirement anyway, especially when an estate is subject to estate or inheritance taxes.

Appraisal results are distributed to beneficiaries.

Beneficiaries might walk through the decedent’s home or storage unit. Each beneficiary would have a batch of sticky flags in a different color, and flag any items he or she wants.

If only one beneficiary wanted a particular item, it would be distributed to that beneficiary.

The combined appraised value of all property distributed to a particular beneficiary would be deducted from the share of the estate’s or trust’s financial assets otherwise distributable to the beneficiary (this means, of course, that items aren’t “free” for beneficiaries, which encourages them to choose thoughtfully).

If two or more beneficiaries want a particular item, the beneficiaries submit one sealed “best” bid for that item to the executor or trustee. The highest bid wins, and the bid amount is subtracted from the beneficiary’s share of the estate or trust’s financial assets.

As noted above, this approach produces transparent and fair results. It may produce lopsided or difficult outcomes when one beneficiary is much wealthier than another – making it easy for him or her to outbid the less wealthy beneficiary.

It’s unusual for clients to have the “bandwidth” to closely consider the particular approach to distributing personal property that they want their executor or trustee to take in their future estate administration.

Instead, it usually falls to an executor or trustee to decide on the distribution approach.

If executor or trustee considers the particular items at issue, the personalities and financial situations of the beneficiaries, they may be able to use one of the approaches described above (or a blend of them) to sidestep conflict, disputes, and bad feelings.

In those instances, better outcomes result all around!

]]>https://www.stitesonestates.com/2015/07/what-about-the-stuff-options-for-distributing-tangible-personal-property-from-estates-or-trusts/feed/0https://www.stitesonestates.com/2015/07/what-about-the-stuff-options-for-distributing-tangible-personal-property-from-estates-or-trusts/Avoiding Family Fights In Estate Administrationhttp://feeds.lexblog.com/~r/StitesOnEstates/~3/21S_Gj37Zwk/
https://www.stitesonestates.com/2015/07/avoiding-family-fights-in-estate-administration/#respondSat, 04 Jul 2015 20:36:02 +0000http://www.stitesonestates.com/?p=3330Continue Reading]]>Estate administration can be a frustrating experience for families and their advisors, because it’s an occasion when families fight. Sometimes the fights are necessary, and unavoidable. Many other times, to a detached observer, the fights seem silly.

Because I think preventable conflict is wasteful, I want to offer some perspective on some of the most predictable conflict triggers in estate administration, along with suggestions for how clients and their advisors can reduce the risk of some of these pitfalls.

Pitfall: End of a Dependent Child’s Financial Support

Many clients have children with very divergent career and life incomes as adults (for more on this, see here). It’s not uncommon for one child to be much less economically secure than his or her siblings. Sometimes the cause is downsizing that ended a career early. Other times, it’s serially unsuccessful entrepreneurship, divorce(s), and/or unresolved addictions.

This sort of child (let’s call them, bluntly, a “dependent” child) has often received financial support from parents that other siblings don’t receive in similar amounts.

In extreme situations, the dependent child continues to live at home with his or her parents and “help” them with various home maintenance and aging issues, often in return for access (direct or indirect) to the parents’ pension income, Social Security, and retirement account required minimum distributions.

Invariably, the dependent child will view financial support he or she received as “gifts,” while his or her siblings will view the same transfers as “loans.”

In a perfect world, aging parents of dependent children would keep clear records clearly proving whether the transfers were gifts or loans. In the real world, those records are usually incomplete or nonexistent.

When the alleged loans aren’t documented, and a sibling other than the dependent sibling is named executor, estate administration can turn into an ugly “witch hunt” that in some ways seems like an effort by the executor to punish a dependent child for having been unsuccessful or irresponsible.

On the other hand, when the dependent child is named executor, any undocumented loans (that weren’t really gifts) are very unlikely to ever be repaid.

Solutions: When a client has a dependent child that receives financial support, keep careful records clarifying whether the support is a gift, a loan, or an advancement against a future inheritance.

Consider not having a dependent child serve as executor, and consider the risks a more financially successful child serving as executor might seek “payback” against a dependent child.

Consider whether use of a bank or trust company executor or co-executor might better preserve sibling relationships.

Pitfall: The Family Home Becomes a Long-Term Holding

Estate administrations often last much longer than they should because children cannot agree about what to do with their parents’ house (particularly if they grew up there and are sentimentally attached to it).

They may claim the housing market is soft (even when it’s not), and that it makes sense to hold the house until a better time to sell. Market timing is difficult to do even when it’s not sentimentally motivated, and I have not seen many of these decisions pay off well for families.

Sometimes adult children have a difficult time accepting that their parents’ house may have failed to keep up with neighborhood trends, because of deferred maintenance, an overgrown yard, or an interior that’s dated. Deferring the pain by waiting to sell usually doesn’t work well.

A parent may have put an amount of money into a “dream” or “trophy” home that wasn’t sensible. In those instances, it can be painful for beneficiaries to compare the “dollars in” to “dollars out,” but as above, deferring the issue doesn’t usually help.

A related situation can involve both a “museum” parental home and a dependent child. Especially if the dependent child has been living in the parents’ home, sheer inertia often means he or she wants to keep living there. The dependent child sometimes arranges to receive the home as part of their overall estate distribution.

Often, this leaves the dependent child with a very distorted balance sheet once the estate administration is over.

Instead of taking income-producing marketable securities as their inheritance and renting a smaller place, the child can end up with a house that demands cash for taxes and repairs, rather than producing it.

The result is a lost chance (often the last chance) to place the dependent adult child on a better footing for his or her own retirement.

Solutions: Consider placing explicit directions in a Will that a house be sold in the course of estate administration, and that good cause be shown by an executor why any sale doesn’t occur within a reasonable period of time (for instance, two years).

Pitfall: Blended Family Discord

As the leading edge of the Boomer generation begins to see more estate administrations, an increasing fraction of these administrations involve blended families.

In my observation, even when a second spouse and step-children get along reasonably well while the step-children’s biological parent is living, once they’re not, the situation often deteriorates.

Will a step-parent inherit all of the biological parent’s personal property (including items the children find sentimental)? If not, will a surviving second spouse lose the use of many ordinary household items like cars and furniture?

How will a step-parent be supported economically?

When the step-parent is much younger than the biological parent (and, therefore, not that much older than the children), will supporting the step-parent delay eventual inheritance of whatever’s left by the children until they are, themselves, in their late 70s?

If the step-parent has his or her own biological children, should he or she be allowed to divert assets to those children in his or her own estate plan?

When there is a family business, how will adult children who continue to work in the business feel about business cash flows supporting the lifestyle needs of a step-parent?

The particulars of any blended family’s demography and balance sheet are very important variables in specific estate planning and administration approaches that make the most sense. Nonetheless, in general outline, consider…

Solutions: Using a corporate executor and/or trustee may provide very reasonably priced insurance against a blended family fight, or litigation.

Relatively moderate amounts of life insurance coverage can provide a “stipend” for adult children whose “core” inheritance will be delayed by its being needed to support the lifestyle of a surviving step-parent who might not be much older.

Great care is probably warranted in deciding whether a surviving step-parent should have powers of appointment over assets held in trust, and if so, the scope of those powers of appointment.

When a family business is key to supporting a step-parent, consider capping annual trust payouts for a step-parent to the greater of trust income or an inflation-adjusted dollar amount. This may increase motivation for children in the business to grow the business, and decrease temptations to boost salaries to insiders at the expense of distributions to shareholders.

No amount of planning by clients and their advisors can remove all of the discord and litigation risks from estate administration, but thoughtful, individualized planning tailored to each client’s particular situation can make better outcomes more likely.

Other Humana transactions may have collateral effects on our city that are to put it mildly, non-accretive.

But, if Tip O’Neill was correct when he famously observed that “all politics is local,” then it’s probably equally true that “all merger impacts are personal.”

What would regional economic risk like a Humana event mean for you?

What are your particular exposures?

Most importantly, what can you do to get ahead of those risks?

Because I believe the right pictures help clarify things, I created an Economic Risk Quadrant to evaluate your personal impacts from regional economic risk (whether sudden, or gradual).

Locating yourself, your business, or your employer on the Economic Risk Quadrant suggests how you might be affected, what you can do to prepare, and how you can most effectively adapt and respond.

In the northwest “Local Income / Local Assets” quadrant of the grid, we have people and enterprises with income streams that are extremely anchored in local relationships, and balance sheets anchored in the same local geography.

Other examples include a teacher or municipal government worker, because local tax revenues underpin their income and the health of their pension funds.

Similarly, a small business owner with local customers will see sales volume rise and fall with the health of the local economy, and the value of their business will fluctuate accordingly.

On the positive side of the ledger, this local/local strategy is resilient to economic shocks, because it usually has a diversified customer base. Income may be disrupted, but is unlikely to go to zero.

In extreme cases, however (such a as a realtor/flipper in a crashed real estate market), the local/local strategy can concentrate risk dangerously.

To reduce risk, individuals in the local/local quadrant could shift their balance sheet on the margin away from local real estate and/or closely held business into a diversified portfolio of marketable securities.

In times of adversity (or, even better, before adversity strikes), the best adaptation strategy for the local/local niche is probably to find new or supplemental products to sell into the existing web of customer relationships.

Examples of this might include a realtor who expands into estate sales, or a municipal employee who develops a paid side income stream as a youth sports coach or referee.

Shifting to the northeast quadrant, we see “Local Income and National Assets.” Individuals in this quadrant have income streams that are highly anchored in local relationships, but tend to build wealth in a diversified portfolio of national or global marketable securities (largely, inside qualified retirement plans).

Examples of this economic niche include financial advisors and regionally-focused attorneys and accountants.

Their skill set tends to be nationally deployable, so they can move if necessary, but moving will disrupt their locally-focused relationships, so it’s an undesirable adaptation strategy.

In the local income / national assets quadrant, the best adaptation strategy when (or before) disruptive events happen is to find new service offerings to sell into preexisting relationships, or find new geographic territories in which to sell the same offering.

For instance, a regional law firm might develop an industry niche, and expand nationally within that niche. Alternatively, an insurance agency might expand into new lines of coverage.

To reduce risk, individuals in the local income / national assets quadrant could increase mobility options by participating in national trade associations, or becoming licensed in other jurisdictions.

In contrast, I think it’s risk-multiplying for a regionally-anchored professional to invest in muti-family or commercial real estate in that same region. (In other words, be cautious about intentionally creating concentrated risks you don’t already have.)

At the southwest quadrant of the grid, we see “National Income and Local Assets.”

In most instances, this means that revenue arrives from outside the community, so events adversely affecting the home economy won’t impair sales.

On the other hand, many “factors of production” such as a factory, warehouse, workforce, transportation infrastructure, and/or governmental regulation are influenced by local events.

Because disrupting factors of production is inconvenient, the short-term mobility of individuals or enterprises in this national income / local assets quadrant is somewhat low.

In the mid-to-longer term, however, it’s easy for these individuals or enterprises to move if they need to, without impairing income streams.

Examples of these individuals and enterprises include manufacturers, college professors, physicians (their patient base is local, but revenues are very often sourced from the state and/or Federal government), large farmers, and business-to-business sales.

When economic disruption threatens, the adaptive response for the national income / local assets quadrant is to develop new sales relationships for the current product, or (possibly), new or different products to sell into the same relationships.

Finally, in the southeast quadrant of “National Income and National Assets“, we see a situation like that many Humana employees might face soon.

For individuals and enterprises in this quadrant, income streams aren’t anchored to a particular locality, and wealth tends to be invested in nationally and globally diversified portfolios.

Examples of this quadrant include executives of Fortune 500 companies, management consultants, attorneys with national or global practices, military families, and senior staff of Federal agencies.

Sometimes, the mobility is by choice – better opportunities arise, and there is little opportunity cost for a move, particularly when one’s employer picks up relocation costs.

Sometimes, the mobility is involuntary, when a transfer occurs, or when an alternative job in advance of or after a layoff or consolidation is located far away.

Adaptation strategies for this quadrant seem to me to be rather limited: find someone else who needs the same product you are selling.

I think the most effective risk reduction strategies for the national / national quadrant include intentional and sustained networking in your industry in other geographies (to assist mobility if needed), and developing a personal brand within your own industry that is independent of your current employer. (For a quick read with valuable advice along these lines, try The Start-up of You by Reid Hoffman.)

These investments aren’t likely to be left “stranded” if your current employer transfers you, in the way community-focused investments of time and energy might be.

This brief overview doesn’t claim to provide answers to some very difficult questions that may personally affect a lot of great friends and good people in Louisville in the months ahead.